Google is down nearly 50% from its 52 week high; it hasn’t been this cheap since 2005! Opportunities like this come around only once in a lifetime. Just buy it and lock it away!
Four simple statements. Two factually true, a third which sets a context, and a final to compel you to act. Stepping back though, we—in truth—have no way to predict whether this “opportunity” will come around again, and even if we could predict that it won’t, it may be absolutely foolish to buy it, and even worse to lock it away.
To be frank, I have no idea what Google is worth and no idea what will be their most profitable product in five years, or a decade. What I do know is that the set of statements deployed above have been used for decades and have motivated money to acquire all sorts of lousy speculations.
Why? Because these statements take advantage of a common human foible—we are easily hypnotized by perceptual contrast. Robert Cialdini, in his Influence: Science and Practice (2nd Ed., HarperCollins, 1988), helpfully describes this foible: “there is a principle in human perception, the contrast principle, that affects the way we see the difference between two things that are presented one after another. Simply put, if the second item is fairly different from the first, we will tend to see it as more different than it actually is. So if we lift a light object first and then lift a heavy object, we will estimate the second object to be heavier than if we had lifted it without first lifting the light one” (12).
Retailers have embraced this insight and recognize that shoppers will perceive something as cheaper—and be more likely to buy—if it is obviously marked down from a higher price, than if they were to merely list it at the lower price. Cialdini relays the example of a realtor who initially showed his clients junky, overpriced “setup” properties before the genuine properties, and the realtor found that the contrast really lit up his clients’ eyes. Auto dealers benefit from this foible when they sell expensive options after the final sales price has been set. Compared to the expensive vehicle, the overpriced options seem rather trivial by comparison, and customers are much more likely to purchase them after the buying decision than before.
Going back to the Google pitch, it looks like something similar is going on. It compels us to frame our perceptions using a relatively opaque signal—price. And we conclude that Google today looks relatively cheap. Then, we elect to act based on the second perception that today’s cheap price is good because historically stocks always tend upward. Buy low and sell high.
I would argue that this common line of thinking is a mental error, and perhaps worse, an error dangerous for your financial health. Rather than investing based on a perceived contrast in price signals, better to invest based on a business’ assets, earnings power, competitive advantages, and capital usage. Google may be cheap today, but compared to what? Its historical price? Well, there may be a good reason for that, and if so, the investor should stay away.
To avoid this perceptual error, many successful investors ignore a business’ current and historical price when screening for potential investments. First they assess the business, then value it, and only then will they look to the market to see if it’s available at a fair price. A contrarian approach, but certainly a useful way to avoid being hypnotized by perceptual contrast.
Disclosure: No position